By February 22, 2023 (Investorideas.com Newswire) KEY INSIGHTS & TAKEAWAYS
CAPITAL RAISES
Transactional Activity:
Seven capital raise transactions with total disclosed proceeds of $69.7M closed this week. Five more transactions closed than last week, and the volume was up by $58.5M. The same number of transactions closed as the previous year, but the volume decreased by $23.1M. This week’s average deal size was $10.0M compared to $13.3M last year.
Cannabis capital raises are off to a multi-year low. Only $312.1M has closed through the first seven weeks of the year compared to $891.1M last year.
Public companies have raised only 59.8% of total capital YTD, down from 79.6% last year.
Cannabis equities (as measured by the MSOS ETF) were up 6.40%% for the week. Capital raise activity was dominated by Tilt’s combined $46.2M refinancing activity.
VIRIDIAN INSIGHTS
Canopy Growth (CGC: Nasdaq), one of the subjects of our Illiquidity vs. Insolvency graph last week, announced a placement of a $150M 5% senior unsecured convertible debenture due 2/28/28. The conversion price will be 92.5% of the VWAP of the stock before conversion. We calculate an effective cost of this debt at approximately 17.5% due to the embedded 100% coverage of 5-year warrants at discount exercise prices. Unsurprisingly, the company has stated that it will not list the notes for trading on any public exchange.
The 3-month vs. 10-year treasury spread is still close to the most inverted since 1981, at negative 102bp. We like to watch this spread as opposed to the more commonly monitored 2yr-10yr spread for two reasons: 1) it is the measure that the Fed focuses more attention on, and 2) this measure does a better job of mirroring bank lending economics. This inversion has successfully predicted the previous five recessions, and we don’t think it will miss this time either. Investors have slowly realized that the Fed is not about to pivot anytime soon since it considers inflation quite ingrained and sticky. The chart below makes it clear that in virtually every case, the yield curve will begin to steepen before the onset of the recession.
Canopy Growth (CGC: Nasdaq), one of the subjects of our Illiquidity vs. Insolvency graph last week, announced a placement of a $150M 5% senior unsecured convertible debenture due 2/28/28. The conversion price will be 92.5% of the VWAP of the stock before conversion. We calculate an effective cost of this debt at approximately 17.5% due to the embedded 100% coverage of 5-year warrants at discount exercise prices. Unsurprisingly, the company has stated that it will not list the notes for trading on any public exchange.
The 3-month vs. 10-year treasury spread is still close to the most inverted since 1981, at negative 102bp. We like to watch this spread as opposed to the more commonly monitored 2yr-10yr spread for two reasons: 1) it is the measure that the Fed focuses more attention on, and 2) this measure does a better job of mirroring bank lending economics. This inversion has successfully predicted the previous five recessions, and we don’t think it will miss this time either. Investors have slowly realized that the Fed is not about to pivot anytime soon since it considers inflation quite ingrained and sticky. The chart below makes it clear that in virtually every case, the yield curve will begin to steepen before the onset of the recession.
YTD Returns by Public Company Category
Large Canadian LPs are still the worst-performing category in YTD returns, despite the 10% recovery in Canopy Growth.
EQUITY RAISES
On February 16, 2023, 1606 Corp. (CBDW: OTC), which offers nicotine-free and tobacco-free alternatives to traditional cigarettes and vaping products using industrial-grade hemp, closed a $20M equity financing agreement with GHS Investments Inc.
GHS has agreed to purchase shares of 1606 at 80% of the market price. Following an uplisting to Nasdaq, the equity purchase price will be 90% of the market price. 1606 is obligated to issue 400,000 shares to GHS as “commitment shares.”
The use of proceeds is to purchase CBD companies.
Sounds vaguely exciting, right? But there are several problems with this picture:
1606 is a tiny company. Total assets as of its September 10Q were $114,652. Q3:22 revenues were $3,762
The company’s statements have a going concern qualification for a good reason. Total assets are composed of $1,543 in cash and $113,109 in inventory. Current liabilities total $718,506, including a $655,050 “Note Payable to related party” (the CEO)
1606 had -$468,000 in cash from operations for the nine months ended 9/30/22
Curiously, the company has 37.1M shares outstanding, which at the closing price of $2.50 gives a market cap of a whopping $92.75M! How can this be? The answer lies in the average daily trading volume of 9,640 shares ($24,100). Given the thin trading, it is impossible to discern the actual market cap of this company.
The financing in question is commonly known as a ‘death spiral” financing, and as the name implies, they rarely turn out well for shareholders. GHS already has 400,000 shares up front as a cushion and is only required to pay 80% of the market price for stock put to them by 1606. But what do you think GHS will do with these shares? We think you are probably on the right track if you said to sell them as fast as possible. For illustration, suppose 1606 put $1M worth of shares to GHS tomorrow. GHS would pay 80% of $2.50 or $2.00 per share and get 500,000 shares for its $1M. With $24K of average volume, what will be the impact when GHS starts selling those shares? Hard to say, but the direction is down sharply. Where will the next set of shares be put to GHS?
Suffice it to say that we doubt that anywhere close to the $20M headline commitment will ever be realized, but it will be a fun one to watch.
Public vs. Private Raises:
Five of this week’s six capital-raising companies are public. Four trade in Canada (three on the CSE and one on the TSX), and all five trade in the U.S. on the OTC.
Equity vs. Debt Cap Raises:
Equity accounted for 32.9% of capital raised this week.
DEBT RAISES
Debt accounted for 43% of trailing 4-week capital raises. We expect this ratio to be volatile because of the limited capital raise activity. Debt should average over 50% of capital raised, especially since many companies are trading at or close to their 52-week lows. We expect more companies to need to add equity kickers to their debt deals in the current capital-constrained environment.
The Week’s Largest Debt Issues
On February 16, 2023, Tilt Holdings (TILT: NEO)(TLLTF: OTCQX), a diversified enterprise with businesses in vape technology, cultivation, manufacturing, processing, brand development, and retail, announced the completion of three refinancing transactions for total gross proceeds of $61.2M.
Tilt completed its previously announced $15M sale-leaseback transaction with Innovative Industrial Properties (IIPR: NYSE) on its White Haven, Pennsylvania Facility.
The company issued $8.2M of PIK secured promissory notes carrying the same interest rate as the notes below. The PIK notes were issued to satisfy outstanding aged accounts payable held by the company’s former Junior Noteholders.
Tilt amended and extended terms with its junior noteholders to provide for new “amended and restated notes” with a principal balance of $38M
The notes carry a floating rate at the higher of 16% of prime +8.5% and mature on February 15, 2026
Amortization payments of $5 million annually plus 50% of excess cash over $10M will begin in February 2024.
Noteholders received 92M 7-year warrants with exercise prices of $.07084. The package represents 17.15% warrant coverage at a premium of 5.574%.
We calculate a value of the warrant package of approximately $2.54M using Black Sholes and a 30% assumed volatility. We calculate effective cost by applying this warrant value as an implied original issue discount of 6.46% and then calculating a yield to maturity of 18.78% without the effect of the amortization payments and 19.14%, including the amortization payments.
We consider this a good deal for Tilt as it compares favorably to the 19.7% effective yield we calculated for MariMed’s recent loan with Chicago Atlantic, even though MariMed is a superior credit by most objective measures to Tilt. The new Tilt notes contain no prepayment penalties, increasing the relative value vs. the MariMed transaction.
Our Chart of the Week ranks Tilt as the third-best credit among the 12 U.S. Cultivation & Retail sector companies with market caps between $10M and $75M. The table below shows the Viridian Credit Tracker ranking of the peer group.
Tilt got these terms partly because Mark Scatterday, a former Tilt CEO and board chairman, owns approximately 1/2 of the issue. It is unclear whether the concentrated ownership of the notes is positive or negative for the company going forward. Still, to the extent that the relationship with Mr. Scatterday remains friendly, it could make obtaining covenant amendments easier, should they be required.
Tilt is an outstanding example of a company that spent nearly a year crafting and negotiating a resolution to a problematic liquidity issue and came out with significantly improved credit.
MERGERS & ACQUISITIONS
Transactional Activity:
Two M&A transactions closed this week for total consideration of $45M compared to four transactions for $68.5M in the prior year.
Twenty-one transactions totaling $195.1M have closed YTD, compared to thirty-four transactions for $1,342.4M last year.
The 2023 YTD average transaction size of $9.28M and the 33% of total consideration accounted for by the U.S. are both the lowest in recent years.
We believe the likelihood of relatively sizeable public/public M&A transactions has increased significantly based on the low trading multiples of tier 2 and 3 MSOs and SSOs, particularly those perceived to be cash flow pressured.
Major Pending Deals Risk Arb
The Cresco/Columbia deal spread widened by 2000bp to 68.0% on 2/17/23, a record level that signals increasing market fears that this transaction will not close as presently structured. An unannualized rate of return of 68% for a less than six-month investment seems too good to be true. Will this transaction fall apart or be recut somehow? What are we missing here?
Valuation Gap
The valuation gap widened slightly to 2.02 on 2/17/23 but remained close to the lowest measure since we began tracking this measure and 120 bps lower than its 52-week average. The valuation gap is the difference between the EV/NTM EBITDA multiple for the largest MSOs and the multiple for the less than $300M market cap group, which are their primary targets.
This measure has been a significant driver of M&A activity since a larger gap creates an opportunity for more accretive transactions. The gap tends to increase in improving markets while declining in retreating markets to the greater trading liquidity of the larger companies.
The Largest Closed M&A Deal of the Week:
On February 13, 2023, Alleaves Inc. (Private), a provider of ERP software systems to the cannabis industry, announced its purchase of Bio-Tech Medical Software, Inc. (BioTrack) from Forian Inc. (FORA: Nasdaq) for a total purchase price of $30M.
$20M of the consideration was paid in cash at closing, and an additional $10M will be delivered in twelve equal monthly installments, subject to working capital adjustments.
Alleaves believes the transaction will accelerate its path to positive EBITDA.
VIEW DEAL TRACKERS
The Viridian Capital Chart of the Week highlights key investment, valuation and M&A trends taken from the Viridian Cannabis Deal Tracker.
Launched in January 2015, and having analyzed more than $60B in deals, the Viridian Cannabis Deal Tracker is a proprietary data service that monitors and analyzes capital raise and M&A activity in the legal cannabis and CBD industries. Each week the Deal Tracker provides proprietary data and market intelligence on transactions, including:
Deals by Industry Sector (To track the flow of capital and M&A Deals by one of 12 Sectors – from Cultivation to Brands to Software)
Deal Structure (Equity/Debt for Capital Raises, Cash/Stock/Earnout for M&A)
Principals to the Transaction (Issuer/Investor/Lender/Acquirer)
Key Deal Terms (Deal Size, Valuation, Pricing, Warrants, Cost of Capital)
Deals by Location of Issuer/Buyer/Seller ( To Track the Flow of Capital and M&A Deals by State and Country)
Credit Ratings (Leverage and Liquidity Ratios)
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